The U.S. Court of Appeals for the Seventh Circuit recently affirmed the dismissal of a bank’s lawsuit against its insurer for breach of contract and bad faith denial of coverage, holding that the insurance policy’s exclusion for any claim based upon or arising from fees or charges applied to the facts alleged.

The bank argued that the primary sources of the claims against it concerned the bank’s policies and procedures, which were not the subject of a policy exclusion. However, the Court held the insurer was not required to defend or indemnify the bank for the underlying $24 million settlement of a class action based on excessive overdraft fees.

A copy of the opinion in BancorpSouth, Inc. v. Federal Insurance Company is available at: Link to Opinion.

A state-chartered bank headquartered in Mississippi purchased a bankers’ professional liability insurance policy, which contained an exclusion from coverage for “Loss on account of any Claim … based upon, arising from, or in consequence of any fees or charges.”

In May 2010, a consumer filed a putative class action against the bank in the U.S. District Court for the Northern District of Florida based on the bank’s allegedly charging excessive overdraft fees. The complaint “asserted claims for breach of contract, unconscionability, conversion, unjust enrichment, and a violation of the Arkansas Deceptive Trade Practice Act.”

The bank reached a settlement in which it agreed to pay $24 million to the class. The bank also notified its insurer of the lawsuit, demanding coverage for defending the lawsuit and indemnification for the settlement.

The insurer denied coverage and the bank sued the insurer, alleging two breach of contract claims, one for breach of the duty to defend and pay attorney’s fees, and another for breach of the duty to indemnify the cost of settlement, as well as a separate claim for bad faith denial of coverage.

The insurer moved to dismiss for failure to state a claim under Fed. R. Civ. P. 12(b)(6), arguing that the claims were based on overdraft fees and thus excluded from coverage because they were “based upon, arising from or were in consequence of fees or charges.”

The trial court found that the exclusion was unambiguous and applied to the overdraft fees at issue, such that the insurer had no duty to defend or indemnify. Accordingly, the trial court dismissed the breach of contract and bad faith claims because “there was no longer an underlying contractual breach upon which [the bank] could recover.” The bank appealed.

On appeal, the bank argued the trial court erred by focusing exclusively on the allegations in the complaint regarding overdraft fees and ignored other allegations concerning the bank’s policies and procedures, which were “the primary sources of harm alleged in the [complaint].”

The Seventh Circuit, applying Mississippi law, explained that “[u]nder Mississippi law, the determination of whether an insurance company has a duty to defend depends upon the comparison of the language contained in the policy with the allegations contained in the complaint in the underlying action.”

Although the bank pointed to multiple paragraphs in the complaint that made no mention of overdraft fees, the Seventh Circuit reasoned that “these individual allegations cannot be read in a vacuum, and instead, must be read in the context of the entire complaint.”

The Court noted that, when read in its entirety, the only harm alleged in the complaint resulted from the allegedly wrongful imposition and collection of overdraft fees and not particular practices such as reordering debits from highest to lowest, which just “assisted in maximizing the assessment and collection of overdraft fees.” Thus, the Seventh Circuit concluded that the trial court correctly dismissed count one of the complaint because “the overdraft fees … were not an additional harm among many. The excessive overdraft fees were the central and only harm.”

The Seventh Circuit explained that “an insurance company’s decision in a banker’s liability policy to exclude losses ‘based upon, arising from, or in consequence of fees’ serves a necessary purpose of avoiding ‘moral hazard.’ … ‘Moral hazard refers to the effect of insurance in causing the insured to relax the care he takes to safeguard his property because the loss will be borne in whole or part by the insurance company.’ If the policy contained no such exclusion, [the bank] could freely create other customer fee schemes knowing that they would be readily reimbursed by [the insurer].”

The Court also rejected the bank’s argument that the trial court erred by finding the exclusion to be unambiguous, concluding that the language’s plain and ordinary meaning was clear and that the trial court “correctly rejected [the bank’s] argument … about whether [the language ‘based upon, arising from or in consequence of any fees or charges’] mean fees payable to or by [the bank]. The exclusion encompasses ‘any fee,’ which would reasonably include either type. A broad exclusion of coverage does not equate to ambiguity.”

Turning to the trial court’s dismissal of the bank’s claim of breach of the duty to indemnify, the Seventh Circuit explained that “[u]nder Mississippi law, the duty to defend is broader than the duty to indemnify. … Whereas a duty to defend arises whenever an insured faces potential liability under the insurance contract, the duty to indemnify kicks in only when the insured is found liable for something that the policy actually covers.”

Because the Seventh Circuit found that there was no duty to defend due to the exclusion for fees, it concluded that the insurer “does not owe a duty to indemnify the cost of settling [the] lawsuit and Count II was correctly dismissed.” Count III for “bad faith denial of coverage was also correctly dismissed since there were no longer underlying claims.”

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Hector Lora has substantial experience in all phases of complex commercial litigation, including motion practice, written discovery, depositions, mediations, bench and jury trials, and appellate practice. For more than a decade, his practice has focused extensively on the defense of civil enforcement actions filed by the FTC, as well as real estate litigation, and contested mortgage and condominium lien foreclosures and foreclosure of security interests under UCC Article 9. Hector also has substantial experience in advising a variety of types of businesses regarding their compliance with applicable federal and state laws, including the Federal Trade Commission Act, the Telephone Consumer Protection Act, the Telemarketing and Consumer Fraud and Abuse Prevention Act, the Telemarketing Sales Rule, the Controlling the Assault of Nonsolicited Pornography and Marketing Act of 2003, and Florida laws governing telephone solicitation and communication. Hector received his Juris Doctor from the Georgetown University Law Center, and his undergraduate degree with honors from the University of Florida.